chapter 3: theories of international trade

Chapter 3: Theories of International Trade & Investment 1Παγ

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section one:the nature of international business3 Παγκοσμιο negócios internacionales

Internationales Geschäft

Affaires Internationales�ة دولّي عمل

國際事務

Busizionali

Chapter ThreeChapter Three Theories of International Trade Theories of International Trade and Investmentand InvestmentΠαγκο

Los negóci

Aff

�ة دولّي مل

國際事務

Business

Buzionali

Intern

äft

международ

διεθνής

cionales

事務

عمل

Ый бизнес

GliAffa

Busine


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Chapter ObjectivesChapter Objectives

Understand the theories of international trade.

Comprehend the arguments of imposing trade restrictions.

Explain the two basic kinds of import restrictions.

Appreciate the relevance of the changing status of tariff and non tariff barriers.

Recognize the weaknesses of GNP/capita as an economic indicator.

Understand the new definition of economic development.

Understand why governments change from import substitution to export promotion.

Explain some of the theories of foreign direct investment.


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International Trade TheoryInternational Trade Theory

Mercantilism Believed nation’s

welfare was in accumulation of stock of precious metals.

Trade surplus created by import restrictions and government subsidies to exporters.

Mercantilist era ended in 1700s.


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Modern Day MercantilismModern Day Mercantilism

Economic Nationalism Industrial policy based on state intervention

France nationalized key industries and banks to use the power of the state as Stockholder and financier Customer and marketer to revitalize the nation’s base In 1986, little growth and high unemployment led

government to reverse “mercantilist” policy

Japan called “fortress of mercantilism” by some Nearly impenetrable market Effort to maintain a cheap yen


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Theory of Absolute AdvantageTheory of Absolute Advantage

“The capacity of one nation to produce more of a good with the same amount of input than another country.” Adam Smith Each nation should specialize in producing goods it

could produce most efficiently In absolute advantage, both nations would gain

from trade.

Assumptions Perfect competition and no transportation costs in a

world of two countries and two products


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Theory of Comparative Theory of Comparative AdvantageAdvantage

“A nation having absolute disadvantages in the production of two goods compared to another nation, has a comparative advantage

in producing the good in which its absolute disadvantage is less.”

Theory of comparative advantage demonstrated by Ricardo in 1817.


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Production Possibility Production Possibility FrontiersFrontiersThe following two

graphs illustrate Chinese and U.S. production possibility frontiers using constant cost for simplicity.

These curves, in the absence of trade, also illustrate the possible combinations of goods for consumption.


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Offshoring Service Jobs to Offshoring Service Jobs to IndiaIndia Approximately 1 Billion people

Comparative advantage in production of goods or services that require large amounts of labor

Citizens speak English Low labor costs due to large workforce Internet and telephone communications much less

expensive Industries offshoring include software engineering,

telemarketing, banking, medical services, claims processing, IT jobs, financial services, insurance

Jobs created overseas generate jobs at home


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Heckscher-Ohlin Theory of Heckscher-Ohlin Theory of Factor EndowmentFactor Endowment States that international and

interregional differences in production costs occur because of differences in the supply of production factors. Therefore,

Assumptions The price of factors

depend only on the factor endowment.

Given technology is universally available.


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Leontief ParadoxLeontief Paradox

Study in 1953 by economist Wassily Leontief disputed the usefulness of the Heckscher-Ohlin Theory as a predictor of the direction of trade.

Found that the U.S., one of the most capital-intensive countries in the world, was exporting labor intensive products.


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Effect of Money on TradeEffect of Money on Trade

Exchange Rate The price of one country’s currency stated in terms

of the other.

Influence of Exchange Rates European companies pressured to increase prices

of exports to maintain Euro profits Currency devaluation


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Newer Explanations of the Newer Explanations of the Direction of TradeDirection of Trade Economies of Scale and

the Experience Curve As output increases

cost per unit decreases Larger and more

efficient equipment Volume discounts Fixed cost allocation Drop in learning

curve

First Mover Theory Gain market share Discourage foreign

entrants

The Linder Theory of Overlapping Demand Customers’ tastes

determined by income levels

Trade greater between nations with similar per capital incomes


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International Product Life International Product Life Cycle (IPLC)Cycle (IPLC) Four stages of the IPLC in

the U.S.

1. U.S. exports

2. Foreign production begins

3. Foreign competition in export markets

4. Import competition in the U.S


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Stages of the International Stages of the International Product Life CycleProduct Life Cycle Exports

Foreign production

Foreign competition

Import competition


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International Technology Life International Technology Life CycleCycle Initial Stage

Development of new technology in an industrialized country

Subsequently exported to other developed countries Increasing cost of labor make it no longer profitable to use in

developed nation

Technology exported to developing nation

Technology produced abroad for domestic consumption


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Porter’s Competitive Porter’s Competitive Advantage of NationsAdvantage of Nations

Porter claims that four kinds of variables will impact a local firm’s ability to use a country’s resources to gain a competitive advantage.

Demand conditions

Factor conditions

Related and supporting industries

Firm strategy, structure, rivalry


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Porter’s Competitive Porter’s Competitive Advantage of NationsAdvantage of Nations Demand Conditions

Nature of domestic demand.

Factor Conditions Level and consumption of

factors of production Lack of natural

endowments has caused nations to invest in the creation of advanced factors

Related and supporting industries Suppliers and industry

support services tend to form a cluster in a given location

Firm Strategy, Structure, Rivalry Extent of domestic

competition, The existence of barriers to

entry The firm’s management

style and organization.


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Trade RestrictionsTrade Restrictions

Arguments for National Defense

Sanctions to Punish Offending Nations

Protect Infant or Dying Industry


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Trade RestrictionsTrade Restrictions

Arguments for Protect Domestic Jobs from Cheap Foreign Labor

Scientific Tariff or Fair Competition

Retaliation


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Other Reasons for RetaliationOther Reasons for Retaliation

Dumping is the selling of a product abroad for less than The average cost of

production in the exporting nation

The market price in the exporting nation

The price to third countries

Result of Excess production Cyclical or seasonal factors Attempt to force domestic

producers out of business


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Sanctions JustifiedSanctions Justified

Dumping for which sanctions are considered justified Social dumping

Lower labor costs and poorer working conditions

Environmental dumping Lax environmental standards

Financial services dumping Low requirements for bank capital/asset ratios

Cultural dumping Cultural barriers aid local firms

Tax dumping Differences in corporate tax rates or special breaks


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Other Reasons for RetaliationOther Reasons for Retaliation

Subsidies Government provides to domestic firm to encourage exports

or protect from imports

Can be Cash payment Government participation in ownership Low-cost loans Preferential tax treatment

Countervailing Duties Set by importing nation to offset effects of subsidy Equal to the subsidy amount


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Types of Restrictions - TariffsTypes of Restrictions - Tariffs

Ad Valorem Percentage of invoice

value

Specific Fixed sum of money per

unit

Compound duty Combination of the

above

Official Prices Minimum import duty

regardless of invoice price

Variable Levy Calculated daily based

on world market price

Lower Duties for Local Input Encourages some local

production


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Types of Restrictions - Types of Restrictions - NontariffNontariff

Quantitative Quotas Voluntary Export Restraints Orderly Marketing Arrangements

Nonquantitative Nontariff Direct government participation in

trade Customs and other administrative

procedures Government and private

standards


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Levels of Economic Levels of Economic DevelopmentDevelopment Developed

Classification for all industrialized nations, which are mostly technologically developed.

Developing Classification for world’s lower income nations, which are less

technically developed.

Newly Industrialzing Countries (NICs) Fast-growing, middle-income or higher economies Heavy concentration of foreign investment Exported large quantities of manufactured goods, including

high-tech products


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Levels of Economic Levels of Economic DevelopmentDevelopment Newly Industrialized Economies (NIEs)

Primarily used to refer to the four tigers Taiwan, Hong Kong, Singapore, South Korea

IMF combines NIEs with Industrialized Nations to form “advanced economies

Emerging Market Economies Chile, Malaysia, China, Thailand, Indonesia

Transition Countries or Eastern Europe Former communist countries


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The World Bank Classification The World Bank Classification SystemSystem Based on GNP/capita

Low income($735 or less)

Lower middle income($736 - $2935)

Upper middle income($2,936 - $9,075)

High income($9,076 or more)


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GNP/Capita as an IndicatorGNP/Capita as an Indicator

Concerns GNP/Capital data does not include Underground

Economy

Currency conversion


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Characteristics of Developing Characteristics of Developing NationsNations GNP/capital less than $9,075

Unequal distribution of income

Technological dualism

Regional dualism

Majority of population working in agricultural sector

Disguised unemployment or underemployment

High population growth

High rate of illiteracy and insufficient educational facilities

Widespread malnutrition and health problems

Political instability

High dependence on a few products

Inhospitable topography

Low savings rates and inadequate banking facilities


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Human Needs Approach to Human Needs Approach to Economic DevelopmentEconomic Development Economic development:

the reduction of poverty, unemployment, and inequality in the distribution of income.

Human Development Index (HDI) based on A long and healthy life Ability to acquire knowledge Access to resources for a decent standard of living Measured by life expectancy, adult literacy, and

GDP/capita adjusted for PPP


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Development TheoryDevelopment Theory

No generally accepted theory

Economists concentrating on Population growth Income distribution Unemployment Transfer of technology Role of government Investment in human

capital


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Contemporary Theories of Contemporary Theories of FDIFDI Monopolistic Advantage Theory

Product and Factor Market Imperfections

International Product Life Cycle

Other Theories Follow-the-leader theory Cross investment Internalization theory Theory of International production

chapter 3: theories of international trade

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